December 30, 2002

WSJ: I Hate Dividends

One of the first tasks for incoming Treasury Secretary John Snow is
fixing the double taxation of dividends, once as corporate profits, and
again by whoever receives them. Go right ahead. But as an investor, I
avoid companies that pay dividends like the plague, and you should too.

Why? Because when they pay a dividend they are admitting they have
nothing better to do with their money. If they won’t invest in
themselves, why should I? In 1887, Theodore Vail quit as the president
of AT&T when the directors of Bell
Telephone declared a dividend rather than investing in his
long-distance subsidiary. I’m with him. He rejoined 20 years
later and built the modern phone company.

Sure, I understand the argument for reform. If companies pay all their cash profits out as dividends, then CEO’s
can’t fudge numbers to drive up their stock, to make their
options worth a ton, so they can buy $15,000 umbrella stands. Pay out
all the cash, and then Wall Street will raise, for a modest fee,
whatever “good” companies need to grow.

Scan the list of companies worth over $10 billion that pay a high
dividend and you don’t exactly come away with the future of
America, more like old home week. Duke Energy (5.6%), Eastman Kodak
(5%), Ford (4.1%), GM (5.4%), JP Morgan Chase (5.6%), SBC
Communications (3.9%), and Verizon (3.9%). Dividends entice investors
into debt-laden, slow- or no-growth companies, more likely to cut their
dividend, burning investors worse than conflicted research analysts.
Run away. They are wearing a scarlet dollar sign. You want yield? Buy a
bond.

Tax policy is loaded with unintended consequences. Higher taxes on
dividends and a lower capital gains tax rate encouraged companies to
buy back their stock instead of pay out cash.

That’s fine with me. My ownership stake goes up, including my
“share” of their future cash. The hardest job for investors
is to pick stocks for their portfolio, seeking high returns. When I
invest in a company, I like to stay invested. If they pay me a
dividend, I have to go through the hassle of finding a home for this
newfound cash. More than likely, I would just invest in the same high
return company that paid me the stupid dividend, so save me the
paperwork and just keep the money. If I need cash or want to sell, I
can do it for a penny a share.

Encouraging dividends clouds analysis. Who would we rather the stock
market provide investment capital to, someone working on hydrogen fuel
cells or dividend paying electric utilities milking 30-year-old
soot-belching power plants? Should the market encourage a company
delivering video over wireless broadband networks or a monopoly phone
company that is over-charging for voice calls on their 50-year-old
copper wires? Should the market help fund a new wonder drug at a
“proteomic” company, or reward the sparse pipeline but
4.8%-yielding Bristol-Myers Squibb for knowing how to navigate the
95-year-old FDA? And should we really be throwing capital at Ford or GM, for any reason?

We’ve just gone through a period of over-funding
entrepreneurs. We all understand that. But let’s not change
policy to favor companies at the end of their lives, at the expense of
those that are finding new ways of generating returns. I’d rather
see dividends and capital gains have equal treatment, preferably with a
0% rate. But, dividends don’t create economic growth. Failing
companies just bribe investors with dividends. Encourage companies with
a future to invest in their operations, seeking high returns. If all
that mattered were dividends, we (and maybe John Snow) would still be
investing in railroad stocks.